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Investing

September 10, 2014

Three investment risks that matter right now

Capital market volatility can be triggered by any number of events. Right now, investors need to understand three key sources of risk.

Being of Scottish descent, I have to confess a bit of a weak spot for aspects of the pro-independence argument being offered to voters in that country this month. I can imagine one or two of my grandparents reacting to the most recent polls with wry smiles, had they lived long enough to see this genuinely historic moment. Next week’s vote could go either way, according to reports.

But while my heart may be (gently) stirred by it all, the thought of a vote in favour of independence from the U.K. gives me a sair heid. Already the British pound is at a 10-month low due to the surging Yes vote. Key Scottish-based stocks have taken a hit, too. Clearly, the majority of investors are pulling for a No result.

Their concern is not unwarranted. Surely the fact that my beloved Scotland has become a source of global investment risk indicates that the state of the world has taken a somewhat perilous turn. Indeed, there are three types of investment risk that you and I need to pay careful attention to in today’s economy:

1. Political risk

As described above. When governments threaten to take action that upsets domestic or international markets, or when certain populations (think protest movements) take steps that can cause assets to lose value, political risk is in play. The nationalization of companies – or even industries – has happened on numerous occasions in developing economies. But political risk can be very much part of the picture in the developed world, too. We saw a clear illustration of this in the U.S. when the federal government shut down for a short time last October. Today’s hot spots include Iraq, Syria, Ukraine and the Eurozone.

2. Currency risk

The one is self-explanatory. Sometimes referred to as exchange-rate risk, this comes up as the price of one currency changes – sometimes dramatically – relative to one or more other currencies. The Canadian dollar has been pretty volatile recently as commodity prices have fluctuated and the pace of our economic recovery has disappointed investors. It’s important to remember that currency risk isn’t simply about your cash holdings. All or most of your investments are likely denominated in Canadian dollars. So they, too, are impacted by a falling loonie.

3. Interest rate risk

Given that central banks around the world have lowered interest rates to support economic growth, investors need to pay careful attention to this. This week marks the fourth anniversary of the Bank of Canada’s decision to set the overnight rate at 1%. That’s the longest period without a rate change in Canadian history. While the overnight rate dropped as low as 0.25% after the financial crisis, it remains very low relative to historic standards. As our recovery picks up steam, investors should expect rates to rise. Rising interest rates negatively impact stock and bond prices.

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